SA risks missing the airline consolidation boat
THE state of the South African airline industry was recently brought into focus by the collapse of 1time. Much of the debate has been about the extent to which the state funding of South African Airways (SAA) and its affiliate airlines may prejudice nonstate-funded airlines, and whether state-owned airlines should be privatised.
All airlines are capital-intensive businesses and the present crisis in SA’s airline industry is not unique to SA. However, in SA’s case, the problems are compounded by the fact that the airlines’ major expenses (aircraft, spare parts and fuel) are priced in dollars or euros, while revenue is generated in rands at an unfavourable exchange rate. To this must be added increasing price competition, high airport and handling fees, regulated maintenance requirements and the cost of highly paid air crews, who are permitted to work for limited hours each week.
Without access to huge amounts of capital, South African airlines simply cannot grow to the scale necessary to maintain profitable operations and to exploit fully the more lucrative African regional routes. Sources of capital are limited. Both 1time and SAA are proof that airline operations are not a ready source of funds for long-term sustainability. While SAA has the state as shareholder, recently announced expected tax-receipt shortfalls (R5bn) are such that continued state support for SAA cannot be guaranteed.
SA’s capital markets are also a poor source of funding. Investors simply do not like airline stocks. 1time ended its life as a penny stock and Comair’s market capitalisation is less than R1bn. There are few companies listed on the JSE able to write cheques of the size necessary to maintain and grow an airline. If the local airline industry is to be saved and to flourish, it is imperative that carriers have access to foreign capital. This is likely to come only with the merger of South African carriers with larger international airlines.
However, foreign ownership of South African carriers is restricted. In terms of the Air Licensing Act of 1990, any person wishing to operate a domestic air service in SA must be a South African resident and, in the case of a resident company, not more than 25% of the voting rights must be held by nonresidents. This limits foreign ownership of a domestic airline to 25%. In the case of international operations, those wishing to operate an international airline from SA have to comply with the International Air Services Act of 1993. This act has similar ownership restrictions. No foreign airline is likely to invest significant amounts in an airline it cannot control.
SA is not unique in restricting foreign ownership of airlines. The US first introduced restrictions in 1926 to protect its airline industry and for national security and safety reasons. Such restrictions have, over time, been replicated in most other countries.
Worldwide, there is a growing recognition that the restrictions on foreign ownership have affected the viability of airlines and run counter to the globalisation trend of other industries. The global financial crisis has simply worsened the funding problems facing the global airline industry.
In 2003, the US proposed increasing the US’s limits on foreign ownership from 25% to 49% but never implemented the proposal. Late last year, the European Commission said it intended to review European Union restrictions and to seek a similar relaxation of US restrictions. Driven by concern about the rapidly expanding Gulf and Chinese airline industry, the commission says about €12bn of economic benefits would be derived from the liberalisation of ownership restrictions. And in a surprise announcement in September last year, the Indian government agreed to allow foreign airlines to own up to 49% of Indian carriers to alleviate the effects of overcapacity and price competition in the Indian airline industry.
In SA, the recently announced conditional offer by Fastjet for the shares in 1time will be an interesting test in relation to foreign ownership restrictions. Fastjet is listed in London and most of its shares (65.61%) are owned by Lonrho. Although Lonrho has a dual listing in SA, it is not clear how Fastjet intends to overcome SA’s foreign ownership restrictions. Although the relevant minister can consent to a relaxation of ownership restrictions, his colleague in the Cabinet responsible for SAA may not appreciate the revival of 1time as a competitor.
The task team appointed to investigate the ownership structure of the state-owned airlines presents an opportunity for the government to review SA’s foreign ownership restrictions. Unless the government is prepared to relax the restrictions significantly, SA is likely to miss out on the global trend towards airline consolidation and the consequent access to capital and economies of scale necessary to sustain the industry. Absent this, we can expect to see more airline failures along the lines of Sun Air, Nationwide, Velvet Sky and 1time.
• Read is an attorney.